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Predicting Future Earnings Changes Using Machine Learning and Detailed Financial Data

Author

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  • XI CHEN
  • YANG HA (TONY) CHO
  • YIWEI DOU
  • BARUCH LEV

Abstract

We use machine learning methods and high‐dimensional detailed financial data to predict the direction of one‐year‐ahead earnings changes. Our models show significant out‐of‐sample predictive power: the area under the receiver operating characteristics curve ranges from 67.52% to 68.66%, significantly higher than the 50% of a random guess. The annual size‐adjusted returns to hedge portfolios formed based on the prediction of our models range from 5.02% to 9.74%. Our models outperform two conventional models that use logistic regressions and small sets of accounting variables, and professional analysts’ forecasts. Analyses suggest that the outperformance relative to the conventional models stems from both nonlinear predictor interactions missed by regressions and the use of more detailed financial data by machine learning.

Suggested Citation

  • Xi Chen & Yang Ha (Tony) Cho & Yiwei Dou & Baruch Lev, 2022. "Predicting Future Earnings Changes Using Machine Learning and Detailed Financial Data," Journal of Accounting Research, Wiley Blackwell, vol. 60(2), pages 467-515, May.
    • Handle: RePEc:bla:joares:v:60:y:2022:i:2:p:467-515
    DOI: 10.1111/1475-679X.12429
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    2. Zhou, Ying & Li, Haoran & Xiao, Zhi & Qiu, Jing, 2023. "A user-centered explainable artificial intelligence approach for financial fraud detection," Finance Research Letters, Elsevier, vol. 58(PA).
    3. Hanauer, Matthias X. & Kalsbach, Tobias, 2023. "Machine learning and the cross-section of emerging market stock returns," Emerging Markets Review, Elsevier, vol. 55(C).
    4. Yuan Liao & Xinjie Ma & Andreas Neuhierl & Zhentao Shi, 2023. "Economic Forecasts Using Many Noises," Papers 2312.05593, arXiv.org, revised Dec 2023.
    5. Zhao, Qi & Xu, Weijun & Ji, Yucheng, 2023. "Predicting financial distress of Chinese listed companies using machine learning: To what extent does textual disclosure matter?," International Review of Financial Analysis, Elsevier, vol. 89(C).
    6. Alex Kim & Maximilian Muhn & Valeri Nikolaev, 2024. "Financial Statement Analysis with Large Language Models," Papers 2407.17866, arXiv.org.
    7. Ken Li, 2024. "Liquidity ratios and corporate failures," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 64(1), pages 1111-1134, March.
    8. Dichev, Ilia & Huang, Xinyi & Lee, Donald K.K & Zhao, Jianxin, 2023. "You have a point - but a point is not enough: The case for distributional forecasts of earnings," SocArXiv 4b2y8, Center for Open Science.

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